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Question
Consider the bond market to be in equilibrium according to our complete theory of the term structure of interest rates. The current interest rate on one-year bonds is 3.0 percent, and you believe, as does everyone in the market, that in one year the interest rate on one-year bonds will be 3.5 percent. Assume that there is no term premium on a one-year bond. Suppose there is a term premium equals 0.75 percent × the number of years to maturity, for the two- year bond. The interest rate today on the two-year bond isa. 3.25 percent.
b. 4.00 percent.
c. 4.75 percent.
d. 5.00 percent.
Answer
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